Surviving the Emerging Market Price Wars: Three Myths & Three Lessons

In ancient Greece, King Pyrrhus of Epirus fought and defeated the Roman army twice during what is now known as the Pyrrhic wars. However, victory was achieved at an ultimately unsustainable cost because of the high burden of casualties. The story is an apt comparison to the far more prosaic challenge of building a pricing strategy in today's fast-changing emerging markets, where companies are enmeshed in ruinous price wars that destroy value and profits for all parties involved.

One recent example, from 2012, involves one of the top 10 manufacturers in Brazil. The company, a leading MNC, wanted to preserve its market leadership and was under pressure from the distribution chain. Discounts on the list prices of its products had reached as high as 95% below those of its major competitors. Coupled with an expected increase in demand ahead of a tax increase, the result was that products from the company flooded the distribution channels. This led to a steep loss in selling power, with many products returned to the manufacturer near their expiration date. And guess who had to foot the bill?

Overall, this strategy led to losses of several hundred million dollars for the company in only one quarter. It was a figure higher than the earning loss from the worldwide patent expiration of one of the multinational company's key blockbuster products. The predicament it faces in Brazil is unfortunately all too familiar to the many manufacturers that strive to beat the performance norm for emerging markets at all costs.

Cash is king

Regardless of recent economic turmoil, key emerging markets remain a significant source of growth for drug companies. While some MNCs haven't fulfilled their ambitious growth targets in emerging markets, Bayer Healthcare and Sanofi are succeeding; emerging markets already account for 30% of their revenues. According to IMS Health, retail sales of pharmaceuticals in Brazil surpassed those of key developed markets like Canada and the UK in 2010 and continue growing at double-digit rates. However, one important characteristic of emerging markets is that most business originates from patients paying out-of-pocket, as opposed to sales funded by the government or private payers, as is common in developed markets. This especially holds true for chronic conditions retail drugs and much less for high-cost drugs such as biologics.

In India, more than 95% of the pharmaceutical expenditure is out-of-pocket, while in China and Brazil patients pay 65% and 80% of the cost of medicines out-of-pocket, respectively. These high rates are only in part due to the limited involvement of public payers in overall health spending. A more important factor is the growth of an emerging middle class with discretionary income that can be spent on products that are not funded through third-party sources.

Pricing out-of-pocket: A different game

Many companies are struggling to maximize their profitability in the out-of-pocket market. There are some important peculiarities that are often overlooked, but need to be considered when designing a strategy for this segment.

» The patient is the main decision-maker: Unlike what happens in reimbursed markets, mere clinical evidence is insufficient to support the value of the product and trigger the buying decision. Apart from perceived clinical benefits, patients will consider other perceptual attributes like the reputation of the manufacturer or even recommendations from family and friends. Looking at the list of top-selling drugs in China, for example, most of the products from MNCs lost patent protection years ago, yet still achieve significant sales. In this sense, the behavior of the patient is more similar to what is seen in the consumer goods industry, where products with a strong perceived brand can avoid comparisons based only on price. More importantly, trust in the brand is vital in the many emerging markets where drug quality and counterfeit products are real issues of concern.

» Importance of stakeholders in distribution channels: Distribution channels involve many players, but sales tend to originate from only a few key accounts. These are typically large retailers with the negotiating power to force manufacturers to offer steep discounts. In Brazil, many manufacturers see 70% or more of their sales coming from just two retail chains.

» Lack of regulated margins: Unlike in many mature markets, retail margins are not fixed by law in many emerging markets. Net prices can be set freely below maximum prices.

» Fierce competition from established local generics: Most of the growth in emerging markets has been captured by local companies specializing in generics. Generic penetration is very strong in emerging markets. In India, for instance, the volume uptake of generics is more than 99%. Many of these manufacturers compete aggressively on price based on low productions costs in order to gain market share. Nevertheless, some of the local companies have managed to stay out of this race to the bottom and are very profitable; the Brazilian company Aché is an example.